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Sunday, December 9, 2012

Tax relief using SRS

Earlier last week, a colleague approached me to discuss about contributing to his Supplementary Retiremnt Scheme (SRS) account for tax relief. I explained to him how I disagree with topping up his account. I will provide some details on the SRS account here and my views on it.

What is the SRS account?
The SRS account is meant to supplement your retirement needs on top of the CPF. Contributions to this account is voluntary. All SRS contributions earn interest similar to prevailing bank saving interests (about 0.05% p.a.). You can use the SRS in investments in regular shares and unit trusts.

Voluntary top up
The maximum amount you can top up is based on a percentage on 17 months of the CPF monthly ceiling (5k for now).
For Singaporeans, it is based on 15%. You can top-up up to 17 * 5000 * 15/100 = $12750
For foreigneers, it is based on 35%. You can top-up up to 17 * 5000 * 35/100 = $29750

What's the catch?
In the example above, we see a tax savings of close to $900 per year! You may then ask: "What is the catch? I can't be getting that amount of savings for nothing"

The SR account is meant for our retirement needs (read: super long term). If you withdraw after age of 62 (based on current rules), 50% of the amount will be subjected to income tax. This amount will be treated as your income for the year you are withdrawing. In short, you are only "delaying" the time where that amount is chargeable for income tax. The advantage here is only 50% will attract income tax.

This does not mean you cannot withdraw early. Unlike CPF, you have the option to withdraw earlier than the age of 62. However, 100% of the withdrawal amount will attract income tax. In addition to this, you need to pay an additional 5% penalty for premature withdrawal.

My views on the SRS scheme:
For someone who do not have the proper knowledge for his/her own retirement planning, it serves as a useful tool. You get to enjoy upfront tax reliefs and contribute to a separate account for retirement needs later on.

However, if you are more savvy in managing your own money, there are several considerations to take note:

1) Income tax during withdrawal after the age of 62.
Your income tax after the age of 62 is dependent on a few factors:a) Your income
The higher your income, the more taxes you need to pay. The amount you withdraw is considered as your "income", 50% of this amount attracts income tax. This is in addition to your annual salary (if you are still working). Let's assume you are still working at that time. Your pay is likely to be higher at that time compared to what it is today. This means that you may end up paying your income taxes at a higher rate after the age of 62 than now.

For example,
Today your chargeable income is at 40k. The 30k-40k income attracts an income tax rate of 3.5%. For every $1000 in this band, you need to pay $35 of taxes.
Say 30 years later, your chargeable income reaches 100k. The 80k-120k income band attracts an income tax rate of 11.5%. You decide to withdraw the money you contributed earlier. 50% of this amount will attract income tax. For every $1000 you withdraw, you need to pay 500 * 11.5/100 = $57.50
This is higher than what you "saved" 30 years ago!.

b) income tax rates
Income tax rates are subjected to changes. With the "aging population" problems that Singapore is facing now, the income tax rates 30 years from now could be higher than what we see today. This could mean that you may need to pay more taxes when you withdraw the amount after the age of 62. This was supposed to help you to save taxes!

2) Rules subjected to changes.
The age 62 should be pegged to the CPF draw-down age, which is increasing due to increase in life expectancy. I do not find it comfortable to place my hard earned money into a "system" that is constantly changing and I having little control over it. If the drawn down age increases to 70 in the future, you will only be able to withdraw without penalty after the age of 70!

2 comments:

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